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Paying Your Taxes and Insurance Through Escrow

When you pay your mortgage, do you know everything that's included in your mortgage payment? Oftentimes, it can be more than just the standard monthly principal and interest. When you own a home, you are also required to pay for your annual property taxes and home insurance. But this can become tedious. So lenders require you to deposit money into an escrow account to make sure your taxes and insurance are paid.


An escrow account--a sort of savings account--is set up to protect the lender from borrowers who miss payments toward their real estate taxes and insurance premiums. If these are not paid, local tax authorities may place a lien on your property. What that means is if the property is being sold, it may cause problems until the party who is owed is paid.

It is possible to avoid escrow and pay your own taxes and insurance. Usually, this is done if your loan-to-value ratio (LTV) is less than 80 percent. If it is more than 80 percent, you may be required to escrow until the mortgage is paid down to less than 80 percent LTV.


However, paying taxes and insurance through escrow can be a great convenience. Mortgages can be complicated enough and this is one less thing homeowners have to worry about. Some find it easier than having to write a large check in the summer and a larger check in the winter for their property taxes as well as other checks to cover insurance premiums.


Things to Watch Out For

You should be aware that even if you have a long-term fixed-rate loan, your mortgage payment can vary. The principal and interest portion of your payment is fixed, as the name suggests. However, tax assessments may change and insurance premiums may fluctuate, thus making your entire payment vary somewhat.


To be able to cover possible shortages in payments, lenders require that an extra two months worth of payments be kept in the account as a reserve cushion. Tax assessments and premium adjustments can happen any time during a 12-month period and lenders will have to cover those shortages either using your escrow account or their own money. If they use their own money, they will recover the shortage by requiring an increase in the amount you deposit monthly into escrow.


Also, when building a new home, understand that your escrow payments may spike when construction is completed. This is due to the fact that when lenders calculate escrow, the number is based on the last disbursement. The last disbursement may only reflect the taxes on the land if there was no previous house on that land. When construction is completed, the land is now worth more because of the existence of the home and therefore, the escrow will be higher.


Lastly, you should always keep an eye on your escrow account since it is always possible for mistakes to occur. It may be a case where the loan is transferring possession from one lender to another and in the interim, wires are crossed and the tax bill gets paid by both lenders or neither. As long as you have made your payments, the onus is on the lender to straighten things out. But the best way to avoid this is to just keep a close eye on things.


Your mortgage payment can include more than just the principal and interest payments--it can also include property taxes and home insurance premiums which can be paid through an escrow account. If you're unsure whether you should escrow, talk to an experienced mortgage banker who can answer all your questions.

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